What is the Difference Between Roth and Traditional IRAs?

December 8, 20226 min read
What is the Difference Between Roth and Traditional IRAs?
Share on facebookShare on TwitterShare on Linkedin

Starting a retirement account or IRA is a great way to start thinking about your future. Essentially, IRAs allow for tax-efficient investing when it comes to retirement planning, but IRA holders should understand how these two options differ. Here, we take a look at the two main types of IRAs, Roth and Traditional, and the differences between them. 

Roth and Traditional IRAs are taxed differently

The key difference between a Roth IRA and a Traditional IRA is that money contributed to a Roth IRA is taxed at the time of contribution and money contributed to a Traditional IRA is taxed at the time of distribution. When a distribution is taken down the road from a Roth IRA, it won’t be taxed. In addition, the rules regarding Roth IRAs disallow people with higher incomes to contribute to them. Typically, Roth IRAs benefit people the longer they are held. 

Traditional IRAs on the other hand, provide a deduction to income when one contributes to them. This means that when you contribute to your IRA, the amount you contribute can be deducted from your taxable income, creating a tax advantage. The gains and income in a Traditional IRA are not taxed while in the IRA. Traditional IRA holders only pay income taxes on the amount distributed down the road.

Roth IRAs and Traditional IRAs have different rules for contribution limits 

Say for example, you are a married individual filing jointly and your adjusted gross income is over $206,000 for 2020. According to the contribution limits for 2023 (see chart below) you wouldn’t be able to contribute to a Roth IRA. For a single person, however, this threshold would be $139,000. 

The following table illustrates the 2023 contribution limits based on your filing status, modified adjusted gross income (MAGI) and explains how much you may contribute based on your age and MAGI for Roth IRAs:

Usually your contributions to a Traditional IRA are deductible against your income so you have a tax advantage. However, there are certain scenarios where your contribution may not be eligible for the deduction:

  1. If you are covered by an employer-sponsored plan or 401(k) and have a high income, your IRA tax deduction is phased out.  
  2. If there is a retirement plan at your work that either you or your employer contribute to. 
  3. You own a business with a retirement plan you are contributing to.

Additionally, you can’t deduct your Traditional IRA contributions if you are one of the lucky few who works for an employer that provides a pension program, like many local, state, and federal governmental organizations. In this case, you can still contribute, but it’s not going to give you a current-year deduction against your income. If any of these scenarios apply to you, it might make sense to contribute to a Roth IRA if you are eligible.

Roth IRAs and Traditional IRAs have different rules around required minimum distributions

Another major difference between these two types of IRAs is that with a Roth IRA, there are no required minimum distributions at age 72 years (and older) like there are for Traditional IRAs. There are some changes to the age limitations on required minimum distributions that came out with the SECURE Act, so it’s important to stay on top of those rule changes. 

Anybody can convert all, or a portion, of a Traditional IRA to a Roth IRA. There are currently no income phaseouts. However, you must pay the income taxes on the converted amount when you make the conversion. After the required holding period of 5 years from the establishment of your first Roth IRA, you can take distributions without paying any taxes. 

It’s important to note that even if you have had a Roth IRA for at least 5 years, you still don’t get the benefits of your new-found Roth status for converted cash and assets for the first 24 months of that particular conversion. 

Comparing Traditional IRA vs Roth IRA returns 

Let’s look at the example of a Traditional IRA owner who converts his or her IRA to a Roth IRA and invests it for 15 years, earning 10% interest. 

At the end of the 15 years, the IRA owner has $41,772 in his/her Roth IRA. This amount can be distributed without paying any income tax. The IRA owner did, however, pay $2,200 in income taxes previously. 

The question is, what would the Traditional IRA have been worth today had it not been converted to a Roth IRA? Let’s compare based on the following assumptions:

  1. The tax rate at the time of Roth conversion and at the time of retirement is 22%
  2. 10% interest rate compounded annually at the end of the year
  3. The Traditional IRA was left alone

It turns out that the Traditional IRA would also be worth $41,772.  However, $9,189 in income taxes would be due when it comes time to take a distribution. So we are comparing paying $2,200 15 years ago, to paying $9,189 today. 

For those who like to do their own calculations, it’s important to consider doing an opportunity cost analysis. This would require you to consider what you could do with the money used to pay taxes on a Roth conversion. 

One of the biggest takeaways from this example is that a Roth IRA conversion has a more significant impact when the time period is longer. It also matters whether a person’s income tax rate is lower when they first contribute, opposed to when they retire. If an investor’s tax rate is higher, however, at the time of conversion compared to when they retire, with everything else staying the same, it is likely that the investor would have been better off not doing a Roth IRA conversion. 

retired-old-couple-difference-between-traditional-and-roth-IRAs

Things to keep in mind about Roth IRAs and Traditional IRAs

The fact is, that as you go about trying to determine which type of IRA is best for you, there is a little bit of a guessing game on what your income level is going to be down the road. There is also some guesswork as to the direction of income tax rates in your bracket when you are taking taxable distributions from a Traditional IRA. 

Oftentimes, when people pay their taxes on a Roth IRA conversion, it is a little like making an investment. It might be the case that someone’s Roth IRA became more valuable than their Traditional IRA because they have to pay taxes on the conversion. For this reason, a smaller balance in a Roth IRA could actually be more valuable than a larger balance in a Traditional IRA to the IRA holder.

When deciding between a Roth and Traditional IRA, and whether or not to do a Roth IRA conversion, there is no right or wrong. As it is impossible to pin down every variable, sometimes the decision of whether or not to make the Roth conversion may involve some guesswork on the IRA holder’s part. Having some solid predictions of what your financial situation is going to be down the road, as well as your personal risk tolerance, may help you with this decision. It might also make sense to sit down with a professional and model out what the best course of action is for you.  

Learn more about how you can take retirement planning to the next level with a Yieldstreet IRA.

Please note that the numbers used here are for illustrative purposes only. Yieldstreet cannot provide tax advice, so please consult a tax professional for advice specific to your situation.

This communication and the information contained in this article are provided for general informational purposes only and should neither be construed nor intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice. Any link to a third-party website (or article contained therein) is not an endorsement, authorization or representation of our affiliation with that third party (or article). We do not exercise control over third-party websites, and we are not responsible or liable for the accuracy, legality, appropriateness or any other aspect of such website (or article contained therein).

We believe our 10 alternative asset classes, track record across 470+ investments, third party reviews, and history of innovation makes Yieldstreet “The leading platform for private market investing,” as compared to other private market investment platforms.

1 Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in significant losses.

3 "Annual interest," "Annualized Return" or "Target Returns" represents a projected annual target rate of interest or annualized target return, and not returns or interest actually obtained by fund investors. “Term" represents the estimated term of the investment; the term of the fund is generally at the discretion of the fund’s manager, and may exceed the estimated term by a significant amount of time. Unless otherwise specified on the fund's offering page, target interest or returns are based on an analysis performed by Yieldstreet of the potential inflows and outflows related to the transactions in which the strategy or fund has engaged and/or is anticipated to engage in over the estimated term of the fund. There is no guarantee that targeted interest or returns will be realized or achieved or that an investment will be successful. Actual performance may deviate from these expectations materially, including due to market or economic factors, portfolio management decisions, modelling error, or other reasons.

4 Reflects the annualized distribution rate that is calculated by taking the most recent quarterly distribution approved by the Fund's Board of Directors and dividing it by prior quarter-end NAV and annualizing it. The Fund’s distribution may exceed its earnings. Therefore, a portion of the Fund’s distribution may be a return of the money you originally invested and represent a return of capital to you for tax purposes.

5 Represents the sum of the interest accrued in the statement period plus the interest paid in the statement period.

6 The internal rate of return ("IRR") represents an average net realized IRR with respect to all matured investments, excluding our Short Term Notes program, weighted by the investment size of each individual investment, made by private investment vehicles managed by YieldStreet Management, LLC from July 1, 2015 through and including July 18th, 2022, after deduction of management fees and all other expenses charged to investments.

7 Investors should carefully consider the investment objectives, risks, charges and expenses of the Yieldstreet Alternative Income Fund before investing. The prospectus for the Yieldstreet Alternative Income Fund contains this and other information about the Fund and can be obtained by emailing [email protected] or by referring to www.yieldstreetalternativeincomefund.com. The prospectus should be read carefully before investing in the Fund. Investments in the Fund are not bank deposits (and thus not insured by the FDIC or by any other federal governmental agency) and are not guaranteed by Yieldstreet or any other party.

8 This tool is for informational purposes only. You should not construe any information provided here as investment advice or a recommendation, endorsement or solicitation to buy any securities offered on Yieldstreet. Yieldstreet is not a fiduciary by virtue of any person's use of or access to this tool. The information provided here is of a general nature and does not address the circumstances of any particular individual or entity. You alone assume the sole responsibility of evaluating the merits and risks associated with the use of this information before making any decisions based on such information.

9 Statistics as of the most recent month end.

300 Park Avenue 15th Floor, New York, NY 10022

844-943-5378

No communication by YieldStreet Inc. or any of its affiliates (collectively, “Yieldstreet™”), through this website or any other medium, should be construed or is intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice, except for specific investment advice that may be provided by YieldStreet Management, LLC pursuant to a written advisory agreement between such entity and the recipient. Nothing on this website is intended as an offer to extend credit, an offer to purchase or sell securities or a solicitation of any securities transaction.

Any financial projections or returns shown on the website are estimated predictions of performance only, are hypothetical, are not based on actual investment results and are not guarantees of future results. Estimated projections do not represent or guarantee the actual results of any transaction, and no representation is made that any transaction will, or is likely to, achieve results or profits similar to those shown. In addition, other financial metrics and calculations shown on the website (including amounts of principal and interest repaid) have not been independently verified or audited and may differ from the actual financial metrics and calculations for any investment, which are contained in the investors’ portfolios. Any investment information contained herein has been secured from sources that Yieldstreet believes are reliable, but we make no representations or warranties as to the accuracy of such information and accept no liability therefore.

Private placement investments are NOT bank deposits (and thus NOT insured by the FDIC or by any other federal governmental agency), are NOT guaranteed by Yieldstreet or any other party, and MAY lose value. Neither the Securities and Exchange Commission nor any federal or state securities commission or regulatory authority has recommended or approved any investment or the accuracy or completeness of any of the information or materials provided by or through the website. Investors must be able to afford the loss of their entire investment.

Investments in private placements are speculative and involve a high degree of risk and those investors who cannot afford to lose their entire investment should not invest. Additionally, investors may receive illiquid and/or restricted securities that may be subject to holding period requirements and/or liquidity concerns. Investments in private placements are highly illiquid and those investors who cannot hold an investment for the long term (at least 5-7 years) should not invest.

Alternative investments should only be part of your overall investment portfolio. Further, the alternative investment portion of your portfolio should include a balanced portfolio of different alternative investments.

Articles or information from third-party media outside of this domain may discuss Yieldstreet or relate to information contained herein, but Yieldstreet does not approve and is not responsible for such content. Hyperlinks to third-party sites, or reproduction of third-party articles, do not constitute an approval or endorsement by Yieldstreet of the linked or reproduced content.

Investing in securities (the "Securities") listed on Yieldstreet™ pose risks, including but not limited to credit risk, interest rate risk, and the risk of losing some or all of the money you invest. Before investing you should: (1) conduct your own investigation and analysis; (2) carefully consider the investment and all related charges, expenses, uncertainties and risks, including all uncertainties and risks described in offering materials; and (3) consult with your own investment, tax, financial and legal advisors. Such Securities are only suitable for accredited investors who understand and are willing and able to accept the high risks associated with private investments.

Investing in private placements requires long-term commitments, the ability to afford to lose the entire investment, and low liquidity needs. This website provides preliminary and general information about the Securities and is intended for initial reference purposes only. It does not summarize or compile all the applicable information. This website does not constitute an offer to sell or buy any securities. No offer or sale of any Securities will occur without the delivery of confidential offering materials and related documents. This information contained herein is qualified by and subject to more detailed information in the applicable offering materials. Yieldstreet™ is not registered as a broker-dealer. Yieldstreet™ does not make any representation or warranty to any prospective investor regarding the legality of an investment in any Yieldstreet Securities.

YieldStreet Inc. is the direct owner of Yieldstreet Management, LLC, which is an SEC-registered investment adviser that manages the Yieldstreet funds and provides investment advice to the Yieldstreet funds, and in certain cases, to retail investors. RealCadre LLC is also indirectly owned by Yieldstreet Inc. RealCadre LLC is a broker-dealer registered with the Securities and Exchange Commission (“SEC”) and a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation (“SIPC”). Information on all FINRA registered broker-dealers can be found on FINRA’s BrokerCheck. Despite its affiliation with Yieldstreet Management, LLC, RealCadre LLC has no role in the investment advisory services received by YieldStreet clients or the management or distribution of the Yieldstreet funds or other securities offered on our through Yieldstreet and its personnel. RealCadre LLC does not solicit, sell, recommend, or place interests in the Yieldstreet funds.

Yieldstreet is not a bank. Certain services are offered through Synapse Financial Technologies, Inc. and its affiliates (collectively, “Synapse”) as well as certain third-party financial services partners. Synapse is not a bank and is not affiliated with Yieldstreet. Bank accounts are established by Evolve Bank & Trust. Brokerage accounts and cash management programs are provided through Synapse Brokerage LLC (“Synapse Brokerage”), an SEC-registered broker-dealer and member of FINRA and SIPC. Additional information about Synapse Brokerage can be found on FINRA’s BrokerCheck. By participating in a Synapse cash management program, you acknowledge receipt of and accept Synapse’s Terms of Service, Privacy Policy, and the applicable disclosures and agreements available in Synapse’s Disclosure Library.

Investment advisory services are only provided to clients of YieldStreet Management, LLC, an investment advisor registered with the Securities and Exchange Commission, pursuant to a written advisory agreement.

Our site uses a third party service to match browser cookies to your mailing address. We then use another company to send special offers through the mail on our behalf. Our company never receives or stores any of this information and our third parties do not provide or sell this information to any other company or service.

Read full disclosure